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Destocking impacts growth...sequential earning beat

AARTI Industries Ltd. (ARTO) is a global leader in Benzene based derivative products. The company has a diversified product portfolio with end users in pharma, agrochemicals, specialty polymers, paints & pigments.

• Revenue growth was lower than estimates on account of the continued impact of inventory destocking coupled with a fall in realization.

• EBITDA de-grew by 13% YoY; however, sequentially, EBITDA grew by 15% and margins expanded by 170bps, led by ease in input prices & operational expenses, which was better than expected.

• ARTO’s 50% are exports, given global inventory destocking, high interest rates, and recessionary trends across various end-user markets that impacted growth. This trend is expected to persist in the near term, while gradual normalization is expected in H2FY24.

• Management has downward revised its EBITDA guidance for FY25E by 5- 10% from earlier Rs.1,700cr. We cut our EPS estimates by 29% & 19% for FY24E & FY25E to factor in demand weakness and higher expenses.

• As per management, the worst impact has been seen in H1FY24, while green shoots of demand revival have been witnessed in dyes, polymers, additives, and some discretionary categories.

• The capex amount of Rs.3,000cr (for adding new +40 value-added products) over FY23-FY25E, is in progress.

• Despite a downward revision in earnings, our confidence is bolstered by the sector's robust growth prospects, ARTO's strategic emphasis on portfolio expansion, aggressive capacity expansion, and the anticipated uptick in long -term contracts.

• Overall, we expect PAT to grow by 12% CAGR over FY23-25E. We value ARTO at a P/E of 32x on FY25E, and maintain BUY rating for the stock, with a target price of Rs. 600, reflecting our conviction in its resilience and potential for sustained growth going ahead.

De-stocking hurt growth….In H2FY24 to see revival

In Q2FY24, ARTO grappled with a 14% YoY decline in revenue, attributed to destocking and realization challenges impacting overall growth. Approximately half of the company's product revenue, characterized by cyclical and discretionary nature, experienced a slowdown in demand. Despite these headwinds, a modest 3% sequential growth emerged, with green shoots of demand revival in dyes, polymer, additives, and certain discretionary categories, while agrochemicals remained weak, expected to recover in FY25. Looking ahead, management anticipates a sequential improvement in revenue growth from H2FY24 onwards. To align with the prevailing demand challenges, we revised our revenue estimates for FY24 and FY25E downward by 18% and 19%, respectively. We anticipate a 10% CAGR revenue growth over FY23- 25E.

EBITDA margin improve sequentially….

In Q2FY24, EBITDA fell by 13% YoY due to lower revenue growth amid destocking, but EBITDA margins improved by 20bps YoY to 16%, driven by gross margin expansion. Sequentially, EBITDA margin saw a 170bps improvement, attributed to lower input costs and reduced operating expenses, surpassing our profitability estimates. While management foresees a 5-10% EBITDA miss in FY25E compared to the earlier Rs.1,700cr guidance, FY24's guided EBITDA range was Rs.900-Rs.1,000cr. The worst impact of raw material price volatility and destocking concluded in H1FY24, with a gradual margin improvement expected from H2FY24 onwards. Acknowledging weak earnings in H1FY24, we revised our EPS estimates downward by 29% and 19% for FY24 and FY25E, while anticipating a 12% CAGR in PAT over FY23-25E.

Valuations

The worst impact of earnings challenges attributed to input price volatility, demand slowdown, and destocking is now behind us. Despite a downward revision in earnings, our confidence is bolstered by the sector's robust growth prospects, ARTO's strategic emphasis on portfolio expansion, aggressive capacity expansion, and the anticipated uptick in long-term contracts. We value ARTO at a P/E of 32x on FY25E and we maintain BUY rating with target price of Rs. 600.

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